MANAGERIAL ACCOUNTING - IIE 211
Variable Costing—A Tool for Management
Overview of Variable and Absorption Costing.
At least two methods can be used
in manufacturing companies to value units of product for accounting purposes—absorption
costing and variable costing. These methods differ only in how they treat fixed manufacturing
Variable costing includes only variable production costs in product
costs. Direct materials, direct labor and variable manufacturing overhead costs would
ordinarily be included in product costs under variable costing. Fixed manufacturing
overhead is not treated as a product cost under this method. Rather, fixed manufacturing
overhead is treated as a period cost and is charged against income each period.
Absorption costing treats
production costs as product costs,
regardless of whether they are variable or fixed. Under absorption costing, a portion of
fixed manufacturing overhead is allocated to each unit of product.
Comparison of Absorption and Variable Costing.
(Exercises 7-3, 7-5, 7-6, 7-8,
and 7-9.) When comparing absorption costing and variable costing income statements, a
number of points should be noted:
Deferral of fixed manufacturing costs under absorption costing.
costing, if inventories increase then a portion of the fixed manufacturing overhead costs
of the current period is deferred to future periods in the inventory account. When the
units are later taken out of inventory and sold, the deferred fixed costs flow through to
the income statement as part of cost of goods sold.
Differences in inventories under the two methods.
The ending inventory figures
under the variable costing and absorption costing methods are different. Under variable
costing, only the variable manufacturing costs are included in inventory. Under
absorption costing, both variable and fixed manufacturing costs are included in
Suitability for CVP analysis.
An absorption costing income statement is not well suited
for providing data for CVP computations since it makes no distinction between fixed and
variable costs. In contrast, the variable costing method classifies costs by behavior and is
very useful in setting-up CVP computations.
Extended Comparison of Income Data.
(Exercises 7-2 and 7-6.) Exhibit 7-3 in the
text presents a comparison of absorption costing and variable costing income statements over
three years in which production is constant but sales vary. Exhibit 7-6 in the text also presents
comparative income statements over three years but holds annual sales constant and varies